Valuations have become more expensive overall as value stocks outperformed the market, according to research from Citi’s global quantitative team. Appetite for risk continued to rise, despite a temporary dip caused by the debt ceiling crisis, and now seems to be a good time for stock picking strategies, the team found.
PE dispersion between cheap (q1) and expensive (q5) baskets
“Recent strong value performance has significantly decreased dispersion in PE between cheap (q1) and expensive (q5) baskets. The cheap baskets around the globe (EU, US and Asia shown) are as expensive as they have ever been,” writes Citi analyst Chris Montagu. “This lack of valuation dispersion limits the upside to value as a stand-alone style.”
Use of different methods to value stocks
Of course, PE dispersion isn’t the only way to look for value stocks (it’s probably more accurate to say that it identifies cheap stocks), but it will be more difficult for value investors to find attractive stocks right now. With S&P 500 performance outpacing performance more or less since the summer, it was probably just a matter of time before value stocks started to catch up. Breaking down performance by investment style, it’s interesting that quality was one of the most consistent strategy last month, and that could be a good way for investors who don’t like to pick stocks to take advantage of the recovery.
Value Investors’ investment strategy
Estimates momentum was actually the most consistent strategy, but basing your investment strategy on estimates is almost as far as you can get from disciplined value investing. As plenty of successful value investors have pointed out in the past, it’s not a strategy that lends itself to trading for its own sake, and it’s important to be disciplined when there aren’t any good deals to be found (not that you should ever stop looking). This might simply be a time of relatively low activity for value strategies.
With valuations high across the board, now could also be a good time to start looking for stocks to short. With such tight PE dispersal, there should be some overvalued stocks getting ready to dip, especially when tapering eventually kicks in and puts more financial pressure on companies’ balance sheets.